Things I Learned This Week While De-cluttering

March 15, 2024

Cost of Energy. Everyone wants a clean world, clean water, clean air, clean streets. Of course, everyone also wants an end to poverty, and world peace. Wanting it does not always make it so. It is usually a process. So, you can go from burning forests, coal fired trains, kids working in coal mines to the smog that used to hang over LA and Denver to today, where the “environment” is much cleaner and the dissatisfaction with the continuing pace is louder than ever. Energy powered mankind’s rise from the beginning of time. The more energy you can generate, the stronger and more successful you will be. The oil and gas industry not only “saved the whales,” literally, but has brought now billions out of poverty or into a better life.

Where is This Rant Going? Europe, and especially Germany, have seen their industrial manufacturing capacity drop significantly, primarily due to the increased energy costs over the last several years. This is much like the exodus of U.S. manufacturing to places like China and Mexico due to the significantly lower labor costs. If we would had known what was going to happen, we might not have lost so much of our industrial manufacturing capacity. It appears the Germans weren’t paying attention. The German industrial model was built by access to cheap Russian natural gas. Due to politics and policies, Russian gas is no longer available and the wind doesn’t always blow, and it is compounded by the desire to shut down all its nuclear power plants. So, German industrial production capacity is declining due to high energy costs, and it is being replaced by China, India and a few others that use the cheapest form of energy they can?

Bottom Line. Actions, policies and mandates all have consequences, not all of which can be known in advance. But it should be clear to all that many of these “energy transition” experiments have resulted in significant loss of employment, economic health and growth and now, national security. Can we stay globally competitive? What we have done so far in reducing pollution and emissions from our industry is amazing and everything done in the industry today, from the well site to the CEO suite, has cleaner operations as a continuing goal. As an industry, there is little we can do but play the cards as dealt and trust that reality is seen early enough to avoid a crash. We will continue to make our industry cleaner, we need to continue to generate positive returns to increase the equity value of the business, and vote. We have a vital industry, and the reality is that we will be a large, critical industry for many more years. The world stage shifting will cause volatility but then, in our industry, that has been a constant. Shifting. Who will be at war with whom in five years? Where will the S&P be? No clue. But the world will be using at least 100 million barrels of oil per day. And more natural gas than today. For our personal lives, I have hopes of world peace and alignment. In our business, the names of the companies might change and ownership is always divided, but wells will still be getting drilled, and everything down the industrial supply chain will continue. The world is increasingly fluid, and the importance of our industry has never been higher.

U.S. Energy Markets Update (From PPHB).

Commodity Prices: WTI crude oil is currently $79.30 per barrel (up ~0.5% week-over-week) and natural gas is $1.78 per MMBtu (down ~8.7% week-over-week)
Crude Oil Production: U.S. crude oil production is currently ~13.1 million barrels per day (up ~7.4% year-over-year)
Crude Oil Inventories: U.S. crude oil inventories decreased by 1.5 million barrels week-over-week vs. an estimated increase of ~0.9 million barrels
Frac Spread Count: There are currently 263 frac spreads operating in the U.S. (a decrease of 9 spreads week-over-week)
Onshore Drilling Rig Count: There are currently 601 drilling rigs operating in the U.S. (a decrease of 7 rigs week-over-week)

Call and Raise. The IEA has raised its estimate of 2024 oil demand growth by 110K BOPD to 1.3mm BOPD, due mainly to terrorism. The Iranian-backed Houthi rebels in Yemen had launched attacks on ships in the Red Sea, forcing them to take the long route to their destinations. The Agency reported that "In February alone, oil on water surged by 85 million barrels as repeated tanker attacks in the Red Sea diverted more cargoes around the Cape of Good Hope." The IEA is estimating that onshore oil stocks globally were at their lowest since at least 2016 as well. The Saudi cuts look to stay in place through the year, even though they have only publicly promised the cuts will be through the second quarter. All of these are giving new ammunition for oil price hawks. These are no longer unidentifiable “black swan” events. They are now part of our daily lives. Few oil supply/demand or inventory models can include issues like this, not knowing where they problems will crop up, but it is increasingly “everywhere.”

Second Opinion. OPEC continues to be more bullish on oil demand growth than the IEA, which really comes as no surprise. OPEC is saying demand could grow by 2.2mm BOPD this year and by 1.8mm BOPD in 2025. The difference of opinion is based on Electric Vehicles (“EV”). The IEA sees a much more rapid adoption rate than OPEC, slowing demand growth. Considering all the negative news on EVs and the cost and effort to mine, smelt, build and dispose of batteries, build charging stations and stay out of cold weather, I think I will take the OPEC view and I am not particularly a real oil bull. But, I do consider myself a realist and the evidence is piling up.

Third Time is a Charm. Analysts at S&P Global Commodity Insights have forecast oil demand to grow by 1.7mm BOPD in 2024 followed by 1.08mm BOPD in 2025. Having been one, I will still stick with OPEC.

Disbelief. The chart below shows the current futures strip for WTI Crude Oil. The Brent curve looks the same. The market is currently betting on oil going back into the $60’s by the end of next year. While virtually everyone in the oil business would take the over on that, the reality is that oil companies cannot take the license to use their own expectations in setting budgets, at least for public companies. Hedge forward production or take your chances? That, we get to decide. Using $85 next year in your planning budget because “you think so” doesn’t and can’t really happen today, and that discipline is what is most likely to make our business a more profitable, less volatile industry. All good things.

Still Strong. I have been a big fan of Weatherford throughout their turnaround and have been very impressed with management. But this time, I will let another analyst weigh in:

Weatherford International has experienced a significant turnaround since its bankruptcy in 2019, with its stock rising ~50x in the past four years.
The company has been exceeding analyst earnings estimates and is expected to continue growing in 2024.
Weatherford has restructured its operations, simplified its supply chain and focused on improving margins, leading to strong financial performance.
We rate WFRD as a buy at current levels.

Always the Optimist. The strategists at Bank of America are saying that equities “are entering a virtuous cycle” after a very positive earnings season. The group raised their earnings estimate for the S&P by 12%. For a 500-company index average, that is amazing. They see U.S. economic growth at 2.7%, more than 2x their previous forecast. While the numbers don’t always hit the mark, having that kind of market momentum would carry things higher, both stocks and hydrocarbon demand. I hope they are right. To be in this business, we have to all be optimists. And right now, we are optimistic they are right.

Headlines.

iPhone Sales in China Fell by a Whopping 24% Over the First Six Weeks of the Year
EV Start-up Fisker has Hired Restructuring Advisors
Putin Rattles Nuclear Saber
Global Warming Didn’t Cause Fires
Texas: The Rising Star of Solar Power
Hess Flags Potential Delay for Chevron Merger as ExxonMobil Fights for “Massive” Oil Discovery Rights Offshore Guyana
TPH: Lower 48 to Shed Rigs Through 3Q Before Gas Plays Rebound
CNX Joins Crowd of Companies Cutting Back NatGas Production
Texas Challenges U.S. EPA Limits on Oil and Gas Industry Methane Emissions

Great Read. OPEC Secretary General put out a very interesting piece this week titled, “If oil disappeared tomorrow…” “If oil disappeared tomorrow, there would be no more jet fuel, gasoline or diesel. Internal combustion engine automobiles, buses, trucks, lorries and coaches would be stranded. Airplanes powered by jet fuel would be grounded. Freight and passenger rail powered by diesel would halt. People could not get to work; children could not get to school. The shipping industry, transporting both freight and passengers, would be devastated.” Emergency services, construction, agriculture and all aspects of today’s economy are touched on in the letter. “If oil disappeared tomorrow, millions of jobs would be lost. Tax revenues would be depleted. Industrial production would crimp. Economic growth would go into reverse. The plight of the fuel poor would be worsened.” Everyone in our industry should share this with their friends and neighbors that don’t fully understand that there is a great deal more from oil than just gasoline.

Double Dribble. President Biden has been a big supporter of unions, framing his IRA to give higher credits on EVs made with union labor and has never mentioned the word “jobs” without putting “union” in front of it. Now this? The Dartmouth College men’s basketball team voted to unionize with the Service Employees International Union, becoming the nation’s first group of student athletes to organize. They voted 13-2 to be represented by SEIU Local 560 in an election overseen by the National Labor Relations Board.

Windfall?? Britain has extended the Energy Profits Levy on UK oil and gas operations until March 31, 2029. This could result in oil companies sending another $5.2 billion of future cash flow to the government. “The tax, with a seven-year lifespan under stable prices, does not abide by most definitions of a ‘windfall’ tax,” according to Wood Mackenzie. As the chart below shows, the return on invested capital (“ROIC”) for three of the largest oil companies significantly trails behind the same metric by the leading technology companies. Look at the chart and remind me who is generating “obscene” profits.

Makin’ Money. Saudi Arabia’s government transferred a further $164 billion stake in Aramco to the Public Investment Fund, a move aimed at bolstering cashflow at the state-backed investor that’s ramping up spending on huge local projects. The 8% stake transfer will cut the government’s direct ownership in the world’s largest oil company to 82%. Thursday’s move will also boost the fund’s assets to about $900 billion, taking it closer to Crown Prince Mohammed bin Salman’s goal of $1 trillion by next year. This week, Aramco posted its numbers for 2023, generating a profit of $121 billion, making it the most profitable country in the world. But when you look at the hundreds of billions needed to produce enough oil, in a somewhat challenged price market, its ROIC still lags behind the biggest tech companies.

Finding More. Lithium has been recovered from produced water in the Permian and the immediate reaction might be to sink some money into it. But beware. In Nevada, potentially the world’s largest lithium deposit in the McDermit Caldera and the Salton Sea in California is being touted as able to provide 40% of global lithium demand. Considering how small the volumes are of lithium from produced water, these could make recovery in the oil business very difficult. When we put our minds to it…

The Beginning. Rivian Automotive is halting plans to build a new multibillion-dollar factory in Georgia, an abrupt reversal aimed at cutting costs while the company prepares to launch a cheaper electric vehicle. The company had just announced job cuts and that production would be flat this year. We noted previously that Rivian was losing about $139,000 per car it sold through the third quarter of last year, and with production flat…

Hi-Tech Workovers? The workover rig business has never been considered very high tech but that may be changing. Axis Energy Services said it successfully launched the industry's first fully electric well service rig, the EPIC RIG, currently deployed on Oxy wells with the ability to run on grid power for reduced emissions and increased fuel flexibility. The rig’s variable frequency drive can connect to the power grid through a transformer, which will eliminate many on-site emissions and save “significantly” on fuel costs, according to the company. I’m still waiting for the virtual rig though.

Nuance Buried in Nuance. I spent years as a geoscientist and years as an analyst and, over the years, I have come to understand that someone will always have an opinion that can be backed up by their math or data. And yes, we spend a great deal of time and money resolving very minute differentiations to find oil. If you didn’t think that happened in every industry, read on.

“The rally comes even as the headline number is expected to accelerate slightly on a monthly basis, while the core gauge cools. The data is seen as perhaps the key release of the month, with options traders hedging for moves in the S&P 500 of 0.9% in either direction after the report — more than after the Fed’s interest rate decision next week. That’s according to Citigroup analysts, who said that a surprise reading might break the equities rally. Bloomberg reporters also flag that the release poses a risk to a $61 billion slate of Treasury auctions this week.” - Bloomberg

Profits Down, Taxes Up. Major oil companies, BP, Eni, ExxonMobil, Chevron, Shell and TotalEnergies, saw 2023 net income drop by 28% and cash flows were down about 19%. It was primarily caused by Brent prices which averaged 17% lower in 2023 compared to 2022. Looking ahead to 2024 and 2025, one would have to believe that, based on the futures curve as it stands today, results should be basically flat with current levels going forward.

Any and all comments, arguments and rebuttals are welcome!

In addition to my association with PPHB, I serve on three private company boards. Merit Advisors is a property valuation company and I have long been a fan of optimizing how a business is run, not just the tools we make. Merit is in the business of savings companies’ money, actual cash, by doing a much more in-depth and realistic view of equipment and reserve valuations and I am very impressed with their work. I am also on the advisory board of Preng & Associates, a leading executive search boutique that specializes in all things related to Energy & Power. Nova is a gas compression company run by a very dynamic CEO with a very strong board and ownership.

I serve on the Advisory board of the Energy Workforce & Technology Council (formerly PESA), the National Ocean Industries Association (NOIA), and the Maguire Energy Institute at SMU my alma mater.

jim

214-755-3914 | james.wicklund@pphb.com

Leveraging deep industry knowledge and experience, since its formation in 2003, PPHB has advised on more than 180 transactions exceeding $11 Billion in total value. PPHB advises in mergers & acquisitions, both sell-side and buy-side, raises institutional private equity and debt and offers debt and restructuring advisory services. The firm provides clients with proven investment banking partners, committed to the industry, and committed to success.